Better news needed

How the economy is faring

By Writing on the Wall - Ashok V. Desai

Published 23.02.16

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I warned in my column on December 8, 2015 that this year would see the worst drought in a quarter century, quite possibly a famine if the government does not act intelligently in time. I now look at the economy, and have equally sombre news to convey about it.

The Central Statistical Office issued a press note towards the end of January with an embargo on publication, telecast or internet circulation till Magha 9, 1937 saka, a day better known as January 29. Buried in its last page was a mea culpa: it changed its recent figures of gross domestic product, net domestic product and gross value added, its new concept. It reduced GDP figures by 1.1 per cent for 2011-12, 0.4 per cent for 2012-13 and 0.6 per cent for 2013-14. It also raised depreciation figures, so the fall in net national product was larger for all three years.

Why did it do so? Earlier it used to base its estimates of industrial production on the annual survey of industry. It covered only registered firms - that is, firms employing over 20 workers, plus those employing 10-19 workers if they used electricity. It changed the sample coverage in 2012-13. The new scheme is complicated. Basically, it takes a sample of companies registered under something called MCA21, which makes all companies file their quarterly returns online. As far as I know, these returns cover financial results; presumably the CSO either deflates sales figures with some price index, or uses data of companies which also give physical production figures. It is also unclear if the output of unincorporated firms is covered.

The figures as they stand now show a massive industrial boom that peaked in 2007. It collapsed at the end of 2008, leading to a fall in industrial output for a while. Then growth recovered, and there was a two-year boom when growth averaged 7 per cent. Then industrial growth collapsed again, and stayed close to zero till the end of 2014. There has been a modest recovery in the past year, but the industrial growth rate remains below 5 per cent.

For the economy, the figures, such as they are, show growth in GVA in the three years 2011-12 to 2013-14 to be 5.4, 6.3, 7.1 per cent respectively; GDP growth is not very different. Fixed investment grew significantly more slowly - at 4.9, 3.4 and 4.9 per cent respectively. Investment-GDP ratio fell from 36.7 per cent in 2011-12 to 34.1 per cent in 2014-15; the fall decelerated growth in total demand. The decline in demand pressure led to an improvement in the current account. Export ratio fell slightly from 24.5 to 23.8 per cent of GDP, while import ratio fell much more from 31.1 to 25.2 per cent; the payments deficit on current account fell from 6.6 to 1.4 per cent of GDP. It may be recalled that the United States of America raised its oil output by means of fracking and reduced imports in this period; that led to a massive fall in world oil prices. Cheaper imported oil was a major factor behind the improvement in India's balance of payments.

The new national accounts make a distinction between construction and real estate. How it is done is not clear. Construction is presumably the activity of building and repairs, while real estate is the owning of and trading in property. Just how such transactions can add value is a mystery. Gross value added was Rs 100 trillion in construction and Rs 170 trillion in real estate, value added to output ratio was 36 and 74 per cent, and investment ratio was 36 and 41 per cent respectively in 2014-15. This is the ratio of investment to gross output, which is different from the ratio of investment to value added used in traditional national accounts statistics; the latter ratio would be higher. Anyway, there are signs of a building boom, which seemed to be tapering off towards the end.

This boom had an unusual feature. Housing in India has traditionally been owned by households, which have led investment in real estate. This changed significantly. Households' savings in the form of physical assets - predominantly real estate - came down from 45 to 33 per cent of financial savings between 2011-12 and 2014-15, while the share of private companies went up from 24 to 34 per cent. Property construction in the form of condominiums, colonies, industrial estates and so on, began to emerge as a major business; construction was on the way to be transformed from a cottage industry into a mass production industry.

Did that lead to a fall in production costs? It is impossible to say since variations in size, quality and location make property one of the most differentiated products. What made news was the unsold inventories of builders. According to a Knight Frank report in the middle of last year, there were unsold stocks of 7,00,000 houses in eight major cities, equal to more than four years' sales. There was, naturally, an enormous fall in construction of new dwellings.

To make things worse, it was reported in October that properties held by real estate developers would be taxed at 10 per cent of property value if the developers are individuals and 30 per cent if they are companies. I have done enough accountancy to know that this is completely irrational: inventories are an asset, and not income. The finance minister could go to Parliament and get it to impose a special tax on builders' inventories; but until he does that, it would be quite improper of his taxwallahs to tax the inventories.

That apart, it is bad economics. As it is, builders with unsold stocks face liquidity problems; taxing them would send them even faster into bankruptcy. And since there is no clear bankruptcy law in this country, their sufferings could go on for years. This would be an excellent way of creating an economic crisis. And the contours of the crisis are already here: borrowers are refusing to repay loans, banks' bad debts are going up, and whenever the prime minister meets them, moneybags complain to him about the bad times and urge him to do something.

To sum up, this National Democratic Alliance government was exceptionally lucky: it came to power at a juncture when the balance of payments was not a worry, inflation was modest and growth was respectable. Good news is boring; to liven things up, the prime minister appointed a finance minister who knows nothing about finance, and got two economists from abroad who are excellent but have little feel for the Indian economy. The result may well beat my worst expectations: we may see an economic slowdown combined with a banking crisis which will cause distress immediately and be remembered for long - like the 1991 crisis.

Can it be avoided? An immediate crisis can be avoided by not taking the punitive action against builders that I mentioned above. But that will only transfer the crisis from builders to banks, already struggling under bad debts. The economy needs some deft handling. While the government has a couple of good economists, I think it needs more intellectual firepower to deal with the crisis.